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May 4, 2018

Flash Crash Anniversary a Reminder of Why We Need CAT and Why the SEC Should Flex Its Muscle to End Industry Procrastination

By Lev Bagramian

This Sunday marks the 8th anniversary of the “Flash Crash,” when nearly one trillion dollars of stock market value was temporarily wiped out from investors’ accounts. This confidence-shattering event took just 18 minutes to unfold and saw some stocks inexplicably plummet to $1 per share while others skyrocketed to more than $100,000 per share. It took regulators months to reconstruct and understand. Reports were issued, hearings were held, promises were made, but even now many questions still remain about what really led to and what really happened during the “Flash Crash.”

While the “Flash Crash” may have been unique in its severity, it would not be the only time a market disruption like this took place between then and now. That’s why the Securities and Exchange Commission (SEC) took action to create better tools to gather and analyze data to better understand the genesis of market disruptions, and, if possible, prevent these events.

One concrete proposal was the creation of a consolidated audit trail (CAT). If properly completed, the CAT system will be the world’s largest data repository for securities transactions, tracking billions of orders, executions, and quotes in all of the equities and options markets every day. More specifically, the CAT will collect order, cancellation, modification, and trade execution information for every trade–someday, it is hoped, in real time. That information will serve two vital functions, enabling the SEC not only to reduce, manage, and better understand market disruptions and crashes, but also to identify, deter, and punish illegal manipulations and other trading abuses – ultimately all in the name of protecting investors and our markets.

The SEC took more than six years to set into motion the building of the CAT. But right from the beginning, this was a compromised project: while the SEC set high-level design and performance standards for the CAT, it outsourced the construction, ownership, and operation of the CAT to an industry dominated group called CAT NMS, LLC. This private company is owned by a consortium of exchanges and industry’s self-regulatory organization (SRO) called FINRA.  By November 15, 2017, the CAT was supposed to be up and running, at least partially. But, it is still paralyzed under the weight of the industry group unable and unwilling to commit to critical decisions that would bring CAT online. For example, firms have refused to begin reporting data to the CAT, in defiance of the November 15th deadline.  Despite Chairman Clayton’s repeated expressions of disappointments, the CAT NMS LLC is still dragging its feet.

But the SEC can do more than express disappointment. In fact, it has all the authority it needs to hold CAT NMS accountable for lack of compliance with the November 15, 2017 deadline. In addition to  the SEC’s general authority to enforce compliances with the securities laws and rules, the specific SEC rule that gave birth to CAT NMS (SEC Rule 613) itself includes a provision mandating compliance by the SROs and specifying that non-compliance could result in fines. Rule 613 states clearly that, “Any failure by a national securities exchange or national securities association to comply with the provisions of the national market system plan approved by the Commission shall be considered a violation…Such enforcement mechanism may include penalties where appropriate.”

So the SEC could and should file a complaint and levy fines for non-compliance. But it hasn’t done so yet. What is holding back the Commission from enforcing its own rules and mandating completion of a mission-critical tool?

It is unacceptable that, eight years after the “Flash Crash,” the CAT system remains unfinished and unimplemented. Such crashes will certainly happen again, just as they have in the past, and it is in the interest of policymakers and all responsible industry participants to arm regulators with effective tools against such events. Until the CAT is operating, the SEC will remain blindfolded in its market surveillance activities, leaving Main Street consumers, millions of investors, and financial markets in harm’s way.

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